Risk, Suitability, and Recommendations Flashcards
(34 cards)
What is the definition of systemic risk?
Systemic risk is the risk of collapse of an entire financial system or market, as opposed to risk associated with any individual entity.
True or False: Non-systemic risks can affect the entire market.
False
Fill in the blank: Systemic risks are often caused by ________ events that impact the entire financial system.
macro-economic
What is an example of a systemic risk?
A banking crisis that leads to widespread financial instability.
Multiple Choice: Which of the following is a characteristic of non-systemic risk? A) Affects the whole market B) Specific to an individual entity C) Linked to economic downturns D) None of the above
B) Specific to an individual entity
What type of risk is associated with a single company’s performance?
Non-systemic risk
True or False: Diversification can help mitigate non-systemic risks.
True
What is one way to manage systemic risk?
Regulatory oversight and intervention.
Fill in the blank: Non-systemic risks are also known as ________ risks.
idiosyncratic
Multiple Choice: Which of the following is NOT a type of systemic risk? A) Market risk B) Credit risk C) Operational risk D) Currency risk
C) Operational risk
What is market risk?
Market risk is the risk that when the overall market declines, so will any portfolio made up of securities from that market.
This risk affects all portfolios regardless of their composition.
How does market risk affect a portfolio of large stocks?
If an index of large stocks is falling, a portfolio of large stocks would likely be falling as well.
The number of stocks and diversity of the portfolio does not mitigate this risk.
What is interest rate risk?
Interest rate risk is defined as a potential change in bond prices caused by a change in market interest rates.
It affects the attractiveness and value of existing bonds.
What happens to existing bonds when interest rates rise?
If interest rates rise, existing bonds will be viewed as less attractive and will go down in value.
This is because their lower coupons compared to new bonds become less appealing.
What is the effect on bond prices when interest rates fall?
If rates fall, existing bonds will be viewed as desirable and will increase in price.
This occurs because their higher coupons become more attractive.
What is duration in the context of bonds?
Duration is a measure of a bond price’s sensitivity to interest rate swings.
It indicates how much the price of a bond will fluctuate with changes in interest rates.
How do bond prices with longer maturities compare to those with shorter maturities in terms of interest rate risk?
The prices of bonds with longer maturities will fluctuate more than the price of bonds with shorter maturities.
This is due to the greater sensitivity of long-term bonds to interest rate changes.
What is inflation risk?
Inflation risk, sometimes called purchasing power risk, is the effect of continually rising prices on a fixed investment income.
It diminishes the purchasing power of fixed income over time.
What happens to fixed-income payments during deflation?
During deflation, fixed-income payments become more valuable because bond investors can buy more goods and services with their interest payments.
This contrasts with inflation, where purchasing power decreases.
Is purchasing power risk present in all securities that pay a fixed income?
Yes, purchasing power risk is present in all securities that pay a fixed income; it is a systematic risk.
This risk affects the real value of income generated by fixed investments.
When are bonds more likely to be called?
When interest rates are falling
Bonds are typically called to refinance at lower interest rates.
What is call protection?
A length of time during which the bond cannot be called
This protects the investor from losing the bond during unfavorable interest rate changes.
When is call protection least impactful?
When interest rates are rising
Call protection is less significant during periods when bonds are unlikely to be called.
Fill in the blank: Call protection is least impactful during times when interest rates are _______.
rising
